NY futures exploded to the upside this week, as December rallied 658 points to close at 88.54 cents (88.85 synthetically).

A bullish WASDE report and strong US export sales injected new life into a market that has been lacking momentum lately. Until today the average daily trading volume averaged just around 20k, even though the market had some big up and down moves this week. After today’s quantum leap the bulls are now back in the driver’s seat, while trade shorts regret not having been more active when the market was trading in the low 80s.

Last week we felt that the tariff war might cast a shadow over the market, but traders shrugged it off and kept their rose-colored glasses on for now, with the US stock market rallying to a four-week high today. The ability for cotton to hold crucial support near 82 cents (long-term uptrend line, 100-day MA, last week’s low) has given the bulls renewed confidence and prompted some light short-covering by the trade this week.

However, considering that open interest is at its highest ever for this time of the year at 253k, volume has been very subdued recently, as neither spec longs nor trade shorts were in any hurry to get out of their positions. This may have changed today, as the USDA has turned up the heat with its unexpectedly bullish WASDE report.

We have been complaining about ‘phantom stocks’ for well over a year and today the USDA took its first step in reducing global inventories to a more realistic level. By making upward revisions to Chinese consumption going back to the 2014/15-season, the USDA cut Chinese ending stocks by nearly 4.6 million bales at the end of next season. The revised stock numbers are now at 37.7 million bales for the current season and 28.5 million bales for next marketing year. While this is a step in the right direction, we feel that these numbers are still around 3-4 million bales too high.

Also, the USDA has yet to address stocks in India, which we believe to be equally overstated at 12.63 million statistical bales (16.17 million local bales). Maybe the USDA just hasn’t gotten around to assessing the Indian situation yet.

Other important changes in the WASDE included a US crop reduction of 1.0 million bales next season, from 19.5 to 18.5 million bales, which was caused by a drop in harvested acreage from 11.12 to 10.50 million acres. Meanwhile US exports for the current season were raised by 0.2 to 16.2 million bales, but were taken down by 0.5 million bales to 15.0 million bales for the coming season. These changes resulted in US ending stocks dropping to 4.0 million bales for the current marketing year and remaining at that level next season.

Strong mill demand has been the main driver behind these higher prices and this is clearly reflected in the USDA report. Global mill use has jumped from 115.8 to 122.2 million bales this season and is expected to reach 127.0 million bales next marketing year. Although global production was able to increase from 106.6 million bales last season to a 123.7 million bales this season, it is becoming harder and harder for production to keep pace with mill use. The current estimate for the coming season is 120.1 million bales, which would fall nearly 7 million bales short of consumption.

In other words, at the current consumption level the world needs to produce near record crops year after year in order to stay level, which is a difficult task. The most the world has ever produced were 127.5 million bales back in 2011/12, in the wake of the historic bull market. What these statistics are telling us is that prices will need to stay high or move even higher in order to incentivize production and/or to discourage mill use.

US export sales got a boost from a lower market last week, as net new sales for the three marketing years amounted to 442,800 running bales. Shipments of 274,600 running bales were slower last week, which was probably due to the 4th of July holiday. For the current marketing year we now have commitments of 17.5 million statistical bales, of which 14.8 million bales have so far been exported. Sales for next marketing year have risen to 6.2 million statistical bales, while there are an additional 1.15 million statistical bales on the books for the 2019/20-season. This means that export commitments spanning from now into the 2019/20-season are totaling over ten million statistical bales!

So where do we go from here? The old adage to “never short a dull market” proved once again to be true . The market has held crucial support near 82 cents and then started to lift off. This means that the spec long, which still measured 9.0 million bales net as of last week, is likely to increase again. Meanwhile trade shorts are kicking themselves for letting another opportunity pass by and some traders are starting to fear this market.

Therefore, we could once again enter a situation in which specs (buying additional longs) and the trade (covering shorts) may both want or need to buy the market, while grower selling may not be strong enough to oppose the advance. Considering how much has already been sold at the grower level, there is not as much selling left to do as in a typical season.

The one thing that still bothers us is the low trading volume. Having a limit up move with just 26k contracts traded seems odd, although volume was probably hampered by the fact that the market was locked limit up for the last hour of trading. However, before jumping on the bullish bandwagon again we need to see confirmation in the form of rising volume and increasing open interest. If this happens, a move back into the low-to-mid 90s becomes the next target.

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